Seattle Need Not Fear Vancouver's Phantom Towers

In his August article on Vancouver’s overheated real estate market,[1] author Charles Mudede studiously unwraps the unwelcome gift of high real estate valuations in Canada’s West Coast metropolis. His article is cautionary, warning Seattle that “Vancouver is the neoliberal city we are all structured to become.” (See the original article in The Stranger.)

It has been nearly two decades since Hong Kong reverted to China’s jurisdiction—when the anticipation of restrictive policies and fears of economic interruptions chased an untold amount of foreign capital and immigrants into Canada. By most accounts, Vancouver was ground zero for such stimulus and our sister city to the north now boasts the greatest Asian population (mostly from China) outside of Asia. It also has a history of knee-jerk policy-making that plays with the intravenous dripline of foreign capital, rather than establishing a more balanced economy where real estate values are connected to population and household incomes vs. foreign buyer demand and investors.

Fortunately for Seattle, our market has been largely overlooked by foreign capital until recently, and so we have spent the last twenty years engineering one of the best and most diversified economies in the US. More recently however, the Seattle/Bellevue metro area has caught the eye of foreign capital, while a series of shifts in Canadian immigration policy and newly implemented taxation of foreign buyers and non-resident investors is diverting attention 150 miles south of Vancouver. As our Emerald City turns to gold, foreign capital will be an ongoing booster shot in an already booming economy. But Seattle is fundamentally different from Vancouver and so we are unlikely to experience the same outcome of empty towers owned by foreign nationals.

HEDGE CITY

Due to the speed with which Vancouver prices have escalated, only the wealthy can board the local real estate train at this point, despite vacancies in some neighborhoods of 50 to 60 percent. Worse, new high-rise condominiums, perhaps the only solution for attainable homeownership, have become stacks of safety deposit boxes for cash-rich investors. Most units re-enter the market as rentals (developers seldom build standalone apartment buildings in Vancouver), but sadly others remain as such—owned, yet dark and unused. Natives of Vancouver find themselves unable to escape the rental phase of household wealth accumulation at a time of zero-percent interest rates on deposits. In fact, and in multiple ways, it is that easy money policy in play around the world that has led to both outcomes—rising prices of assets, and an inability to save—that prevail in all West Coast cities, though by different degrees and with different effects on the residents of each. For now, Seattle appears to be the most affordable of global gateways on the Pacific—but the tides are rising.

Throughout his analysis, Mudede treats this mainly as a regulatory challenge that might be met by closer scrutiny and bold action by provincial officials on such matters as landlord-tenant law (to counter reportedly hard-hearted avarice of landlords), as well as regulations on transactions, such as the 15-percent foreign-buyer’s tax enacted this month by BC Premier Christy Clark’s government. Such high taxes on inbound foreign capital and transactions are necessary because, according to Mudede, the free flow of capital is adverse to “democratic accountability.”

First, any implication that the vacancies troubling Vancouver are a rogue wave heading toward Seattle are unfounded. Unlike in Vancouver, developers in Seattle have built apartment buildings aimed at rental income streams.[2] They have added more than 13,000 units to the urban neighborhoods since 2011 alone, whereas fewer than 900 condominium units were built for sale. Simply put, the inventory is not in the hands of foreign investors seeking financial safe harbor, but rather large institutions seeking to profit from rising rents, with seemingly insatiable demand thanks to a robust job market. In June of this year, apartment vacancies in Seattle are as low as any seen in over a decade.[3] With room to grow (albeit vertically), Seattle is building to meet the demand.

Second, and counter to Mudede’s proposed solutions, is the question of whether in fact government regulation can achieve its intended results when the origin of the problem is in international money creation carried on with the government’s consent. We refer to the process of extreme central bank intervention that has been going on worldwide for decades and that accelerated in the immediate aftermath of the Great Financial Crisis. The experiments undertaken since then were not limited to the West; foreign governments in Japan and China embraced them with alacrity. Enormous fortunes were made, and some went abroad seeking safe haven. Others followed, knowing what that flight of foreign capital means in terms of local real estate returns.

CANADA: THE BUSINESS OF IMMIGRATION

The Canadian government invited this money in when they instituted their investor visa program. Unlike the U.S. EB-5 program, business and job creation were never directly factored into the original Canadian program, which required only the commitment of funds interest-free for government use. This was money that the Canadian government regarded as needful for economic stimulus in their domestic economy. Whether they anticipated the amount of capital that was being stimulated into existence overseas at that time, particularly in China, is another matter, but one that as it turns out has had enormous implications for the program’s outcomes in Canada’s cities, especially in Vancouver. As Mudede reports, the proportion of single-family homes in Greater Vancouver valued at C$1 million or more rose from 19 percent to 91 percent in 10 years. Not only did property values increase, but oftentimes the invested foreign wealth came in the form of a mother and child, while the father remained at work in China without reporting the household’s foreign income for taxes due to Revenue Canada. Furthermore, in Canada, capital gains earned on the sale of a principal residence are tax-free, so when the resident finally does sell and realizes millions of dollars in capital appreciation, Revenue Canada misses out again. The silver lining for locals is that their house is likely to be worth much more; but for those that have yet to buy, finding affordable housing based upon income is going to be tough if not impossible.

OLD-FASHIONED FUNDAMENTALS

Mudede correctly observes that Vancouver’s technology industry salaries are but nearly half of their equivalents in Seattle. This is because Seattle, like San Francisco and San Jose, is home to a highly competitive and technologically-driven local industry with many big, established companies and global brands: Microsoft, Amazon, and Google to name just a few. Seattle’s high-tech industry grew up in tandem with those of the Bay Area, whose economies and property prices saw proportionally greater growth, in part due to the historically stronger presence of venture capital in that region. But the lack of a state income tax in Washington and relative affordability has made Seattle and Bellevue popular destinations for tech campuses and employment fulfilment, driving local and sustained housing demand of all types.

In Seattle and San Francisco, the effects of low interest rates and Federal Reserve intervention in the financial markets have allowed the largest of these companies to go on a sustained capital investment and spending spree, buying up smaller companies, hiring new workers, and directly participating in real estate markets in their host regions. The newly-hired workers are offered the superior salaries that these employers can afford, providing a secondary stimulus to residential prices. The looming threat of negative interest rates now being toyed with internationally poses a disincentive to holding cash, and is thus likely to drive yet more investment toward the accumulation of real estate and other hard assets.

In the Bay Area, the outcome of this extended, debt-fueled party has been to exhaust the availability of buildable lots in the region, raising prices to the ceiling and driving away everyone not at least peripherally connected to the region’s core industries. Indeed, even people whose careers are interwoven with the high-tech industry increasingly find homeownership out of reach. This was most poignantly demonstrated by Palo Alto city councilmember Kate Downing in her resignation letter last week (reported August 10, 2016)”[4]. Frustrated by their inability to buy a home in Palo Alto, corporate attorney Downing announced her and her software engineer husband’s plans to move to Santa Cruz.

The median house price in San Francisco reached $1.2 million in June 2016, [5] nearly double the median price of $650,000 in Seattle that month.[6] Notably, prices have been rising; the Seattle price is 16.6 percent higher than that of the preceding June and exceeding the rate of escalation of all other US cities, except for its neighbor, Portland, Oregon. Even more significant, the median home prices of downtown Seattle condominiums have swelled to $682,300 in July, rising 32 percent above the prior year and 52 percent higher than the pre-recession peak. Meanwhile, a recent report by Zillow ranks Seattle fifth among markets with the highest shares of renters qualified to buy—reportedly 22% of the area tenants could make a move to homeownership and challenge the limited supply even further.

Vancouver, Seattle and San Francisco do share one determining characteristic: geography. Each are effectively island cities surrounded by waterways, mountains and restrictive zoning that forces vertical development and higher prices. These cities lack the option to sprawl into hinterlands as Houston and even Beijing have in search of affordability, so it is just a matter of time and money before they look more like Hong Kong.

SEATTLE 2.0

Among both domestic and international buyers, demand for property in Seattle has risen with its reputation as a tech mecca. The myth of perpetual rain and overcast skies in Seattle has evaporated, as anyone spending the sunny summer of 2016 here can attest. A report by JLL declares that “Seattle is just about perfect for Millennials,” ranking it third in desirability behind New York City and San Francisco. The greasier businesses of lumber production and aircraft manufacture have long been receding in influence, if not in presence in the case of the latter. With new development projects in the pipeline, what remains of Seattle’s open space within its urban growth boundaries is due to be filled with luxurious high-rise apartment buildings, condominiums and office towers in what Realogics Sotheby’s International Realty’s owner, Dean Jones has termed “The Manhattanization of Seattle.” And like the Big Apple, the seeds of growth are incubating within its core.

One more remark by Mudede that calls for some skepticism is his assertion that “Seattle has no capital controls, so money can enter or exit its markets easily.” If only it were that simple. Financial institutions in nearly all Western countries are now subject to strict anti-money-laundering policies and practices that make it much more difficult to receive funds across borders than in the past. Add in FATCA declarations and capital controls overseas, such as in China, and the prospects for further capital inflows to Washington State can be seen for what they are: real and substantial, but not without limits. That said, provincial regulations enacted to curb foreign purchases, such as those now in place in the Lower Mainland in Vancouver, are likely to push some prospective buyers toward competing markets, including the Central Puget Sound. That’s precisely what happened in 2014, when the Canadian government abruptly cancelled nearly 60,000 applications—most of them Chinese—for investment visas under its old program, and created an instant catalyst for the U.S. alternative. With the new transfer tax on foreign buyers in Vancouver, history is likely to repeat itself. Going forward, we foresee strong-but-rational price growth that benefits both sellers and buyers here, without foreclosing their children’s futures. And any additional foreign buyer activity will be on top of Seattle’s already significant domestic economic fundamentals.

VANCOUVER: NOT SO MUCH

Burrard Group, an international real estate development company based in Vancouver recently introduced a 374-unit high-rise condominium called NEXUS in downtown Seattle. As one of the few “for sale” opportunities in the fast-growing city, eager buyers camped out overnight, and within a weekend, 80 percent of the homes were reserved. While the progressive designs and rapid absorption resemble those found in Vancouver’s hot real estate market, as stated, the buyer profile in Vancouver is different. Michael Cannon, Sales Director for NEXUS reports that by far, the buyer profiles reflected local buyers intending to be principal residents and second homebuyers, with only a minority of investors. Not surprisingly, the largest single demographic was urban dwellers working in the tech industry, many of whom are renting with monthly payments that could support a mortgage. All reservation holders are required to be pre-qualified, certifying that only a handful are considered “foreign buyers.” And knowing that any investment condos could fetch much higher rents than a similar apartment in Vancouver, the temptation to leave a home vacant seems unlikely. Certainly, foreign buyers will be attracted to new projects such as this one; but clearly they will need to get to the front of the line, which at NEXUS began twelve hours before the door opened for reservations, let alone purchases. The point is there are plenty of local buyers.

NEXUS, as it will soon be experienced in downtown Seattle, as the stacked cube architecture takes first and foremost among the burgeoning East Village neighborhood.

Ultimately, we find scarcely any risk of a Vancouver-like outcome in Seattle. The pattern seen in San Francisco is more concernedly realistic in the event that the current global financial conditions persist. In this event, we are not as hopeful as Mudede that more government regulation will be palliative. Rather, we advise would-be buyers to get aboard, strap in, and hold on.

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